Friday, October 12, 2007

Sounds like a nice problem to have, right? :)What I really mean is that as of my latest monthly recap, 8.6% of my net worth is in cash, bank accounts, and CDs. I'm not getting very high rates of return on most of this. At this writing, here's what I'm earning:

I hadn't really been paying enough attention to these interest rates, and now that I am, I realize how pathetic they are! That money market account used to earn over 4%, I'm pretty sure. And my savings account used to be around 2%, I thought. Anyway, this is just ridiculous and I want to take action right away.

One option would be to open a new savings account with one of the higher interest internet banks. I had an account with Presidential for a while at 5%, which I closed out when I had to pay for my condo. At My Money Blog, Jonathan has a good comparison of some online savings accounts. Looks like I could get 5.05% at FNBO, or 5% at WaMu, which might be worth considering just because they have local branches. (That almost makes me want to give up my Chase accounts entirely but I can't bring myself to ditch my savings account there because the account number is THE BEST BANK ACCOUNT NUMBER EVER, as my accountant reminds me every year! And I have to agree that it has a beautiful symmetry to it.)

So I'll be looking into getting a new savings account where I can do online transfers and use that as a better place to park some of this money. But that is only one step. I think I should be putting some more of this money into investments with a better potential return. First I have to decide how much money I want to keep in cash. I've never really maintained an "emergency fund" of any particular amount. My view on this is that since my income is steady and my job seems relatively secure, I can basically consider ALL my money to be a kind of emergency fund. I have cash and CDs and mutual funds, etc. and in a true emergency, I could draw on any of those, or even take money out of my 401k if I had to. If I had less money and more debt, or a fluctuating income, I'd have a totally different attitude about this, of course.

But all that said, I do think it's wise to have some cash on hand to cover a couple months' worth of expenses. Given how high my expenses are lately, I'm suddenly feeling like maybe I don't have as much extra cash as I thought! Not including income taxes and other paycheck deductions, I tend to be spending around $4,000 a month lately. If I lost my job suddenly, I would certainly change my habits and lower those expenses quite a bit, but housing and utilities come to about half of that, so there's only so low it can go. So should I be keeping more like $10,000 in cash? For the reasons I cited above, I don't think so. I think a cushion of $6,000 or $7,000 in a savings account should be ok for now, especially since I should have a bonus coming within the next 6 months. So I think I could open an online savings account with $6,000 or so, and then take $15,000 or so out of that money market account and use it for other investments.

So then I have to decide what kind of investing I want to do. Stocks? Mutual funds? ETFs? Bonds? I already have some money tied up in all of these things except ETFs. Frankly, I don't know all that much about ETFs and don't think I want to take the time to learn right now, so I'm ruling those out. As for individual stocks, I've dabbled in them in the past, and I kind of like the idea of investing in a specific company whose performance I can monitor, but again, I think that takes a willingness to invest time and effort as well as money. I don't have the expertise or the energy to do the research I think I should.That leaves mutual funds. In the past, I've attempted to pick out individual mutual funds from different companies that seemed to be doing well, but now I think it's probably best to just find funds with low expense ratios and pick a couple different index funds. I've always used E*Trade for all my stock and mutual fund purchases outside of my 401k, but I'm wondering if I should look into opening a direct account with Vanguard. I'm also wondering if I should make it a traditional IRA, or a 529 college savings account for my niece and nephew... Now I'm getting into more complicated decision-making, but I really want to take action on this quickly. I'll be thinking it over, and hopefully by the next time I post a monthly recap, some of those account balances will be very different!

29 comments:

We were debating a while ago whether we wanted to start 529 accounts for our nieces & nephew. But then we decided that we'd be better off saving for our retirement and then by the time they go to college we'd be able to help them pay for college out of our salary (since we won't have a house payment & we should have a good amount saved for retirement).

Have you considered a Roth IRA? I definitely think it makes sense to keep some in an online savings account (I personally love Fidelity's money market mutual funds; I get over 5% consistently), but then push money into a Roth IRA over and above the online savings account.

Roth IRAs are a beautiful thing, especially since you get to draw down the contributions you made to them without any penalty.

If you have a bulk amount to invest, go ETF.

If you have a little each month to invest, go mutual fund (preferably index fund).

ETFs are super easy to figure out, they are very similiar to index funds, but lower costs.

However since they are listed on an exchange, they incur transaction fees when you buy/sell (which is not an issue if you have bulk amount to purchase/sell).

For example, bonus money = ETFs. monthly paycheck = index funds.

Also, think about short term/long term money.

For example, any money you want in less than 5 years should be in a savings account.

Any money over that (for 5+ years) should be in a vehicle like an ETF or a mutual fund.

Why? Because you will level out the volatility the longer you are invested, as you already know.

I'd go with WaMu in your case. Open a high-yield savings and free checking, and you can link them online for instant transfers (so you can literally keep a $1 balance in there between payments if you wanted). Their local ATMs are also very nice, but I believe they also refund withdrawal fees from other ATMs.

For a better online savings account, go to bankrate.com and do some research. You can get an account that lets you write checks and do other useful things, and the best now pay you about 5%, which is not a bad return on an investment. I save just a little automatically every month, and now I have enough for two months of expenses.

A secure job is certainly the best way to pay for your life. I have a pretty secure job, too, but I don't have all that much financial wiggle room, and knowing I have some money saved, easily available but earning interest, makes me feel more secure. It's insurance money I can get without going through an insurance company. And if you have some funds in a liquid emergency fund, that gives you time to liquidate other funds if you need them.

You can never tell what will happen. I recently had a medical problem that required treatments not covered by my health insurance. I was very glad I had cash to pay for them.

Since you already have an account at E*Trade you should open a savings account there, it pays 5.05%. Then put all that cash you have laying around in there until you decide what to do with it.

It would definitely be in your best interest to learn about ETFs. You can trade them in your E*Trade account for low commissions and they generally have very low expense ratios. ETFs are basically mutual funds you trade like stocks. Check out etfconnect.com for good information.

I would suggest opening a higher yielding money market account with Flagstar Bank (5.11%) for your emergency fund as they provide checkbook and ATM card.

The balance can then be invested with E*Trade in International Stocks to maximize the rate of return. Since you already have a E*Trade account you can easily move the money from E*trade Trading account and Savings account to save transaction time.

I like your idea about opening an account directly with Vanguard. I hope to do that at some point, when I have the money. They have some good funds and you could keep an eye on it a few times per year. So not too hard to work and profitable.

Learning about ETFs might also be a good move, but if you don't have the time then Vanguard seems like a safe choice.

isn't a CD just a certificate saying you made a deposit with a sometimes okay interest rate. i thought CD's were for short term use or is that the reason you use them. you plan to use the money in the next 6 months or a year or 5 years?

I know that you didn't list this as one of the options that you are considering, but you could also just put the cash towards paying off your housing. It's not quite the same approach as saving/investing it, but ultimately decreasing your liabilities gives you the same result as increasing your assets from a bottom line standpoint. Whether the benefits from this would be greater than those from investing it obviously depend on the relative rates involved, but at least it's another option to consider. Otherwise, I agree with the ETF-supporters above, but of course there is also a risk factor involved to that (and then the opportunity cost of time used to do the necessary research, etc.). Anyways, at least it's always better to be in a situation where you're trying to decide what to do with excess cash than how to get cash you need and don't have, right?

We love our savings accounts with HSBC. It is completely online, and so easy to transfer to/from our other bank and investments accounts. The interest rate is not what you'd get on a mutual fund, but still much better than all of your current cash holding rates.

P.S. We also have a new online Vanguard account that, so far, has been great. Easy to use and very low fees. Too early to see what kind of returns we are getting, but the customer service has been very helpful and responsive in getting everything set up.

I like my setup. My emergency fund is vanguard money market with check writing services. I have my emergency checkbook kept in a special place. The rest I have in vanguard index funds. You will want to get 10k in a fund to avoid any fees but you might consider part in the total stock market and the other part in the tax managed international. It's simple...it works...and all my friends who listened to me love me.

Madame X, the Roth IRA is a great deal, but you're now reaching possible income limits. After $99,000 per year (for a single filer), you can no longer make the full Roth contribution (and none at all after $114,000). Keep that in mind since you're projecting an income of about $100,000 (but I don't know if that's this year or next).

If you do make a Roth contribution and discover that you couldn't have done so, you can recharacterize the contribution as a traditional IRA. It might not be a terrible idea to wait until after 2007 is over and you know your income before making your Roth contribution.

I am also a big fan of ETFs since I buy and hold and buy in a lot of bulk all at once. (I also avoid trading fees by rebalancing when I buy, i.e. buying less of the ETFs which are over their target percentage and more of the ETFs under it, rather than rebalancing throughout the year.)

By the way, on the subject of withdrawing Roth IRA contributions tax-free and penalty-free, I agree that it's an advantage of Roths, but it's not a huge advantage. (The huge advantage is the tax-free growth.) In general, one should avoid withdrawing contributions at almost all costs since you can't put the money back in and you're limited in how much you can contribute each year. Having said that, I often tell people who have an either/or choice between funding a Roth or hanging on to an emergency fund that they should fund the Roth. They win if they don't need need it as an emergency fund, and they're no worse off than if they hadn't funded it if they do need it (unless they make less money in the investment than they would have made in interest, but that's likely to be a very small amount). Having said all that, it's nice to know that I have my Roth contributions as a "grave emergency fund." (Though I'm very well-insured and have a large regular emergency fund, so it's hard to imagine an emergency which would make me tap my Roth.)

By the way, those are very low interest rates. My online savings account (E-loan, which I don't necessarily recommend, though I've been happy with it) is paying 4.75%, higher than all of your balances except the 2-year CD. Oh, and E-Trade isn't at 5.05% any more; the previous commenter is slightly behind the times. It's now at 4.70%.

I don't have much to offer on the investing front, but I'm getting a little messianic about my brand new online savings account from ShoreBank, which not only is at 5.00% APY, but also is a community development bank, which means the money supports low-income communities (small business loans, affordable housing, etc) and environmentally friendly construction and renovation. I think it's so cool!

The link to sign up for the account /read more is here. I just wrote a post about ShoreBank and this account here.

I vote for traditional IRA. Beginning in 2010, income limits for the Roth go away and non-Roth IRA's can be converted. Makes much more sense to me to start a traditional IRA now and then roll it over to a Roth in 2010 than wait until you get your taxes done to see how much you can contribute.

Just to clarify Frugal Zeitgeist's comment, income limits for the Roth do not go away in 2010. What does go away is income limits on Roth conversions. (So you can contribute to a traditional IRA and then convert it to a Roth in 2010, no matter how much money you make.) I think there is an excellent chance that Congress will change this before 2010 actually happens. Of course, they very well might not, but I wouldn't count on that. If you do qualify for a Roth, you should probably make it a Roth immediately, rather than counting on being able to convert in 2010. Of course, if you don't qualify for a Roth, then it does no harm to contribute to a traditional and hope you can convert it then and I would certainly recommend that.

Moreover, if you contribute to a Roth now, you pay the taxes now (on your contribution). If you contribute to a traditional now and roll it over in 2010, you pay the taxes then on the contribution and the earnings. Unless you're expecting gains below inflation, you're better off paying the taxes now if you can. (If you can't, then of course, make it a traditional.)

Thanks for clarifying my sucky wording, andrew. Regarding traditional IRA's: I was thinking that if Madame X is not eligible for a full Roth contribution, she would probably not be eligible for a deductible traditional IRA. You're quite right about having to pay tax on the growth during a conversion, though.

Thinking about it further, Madame X will probably be able to contribute fully to a Roth since her mortgage is deductible. In that case, it does make sense to wait on making an IRA contribution until she gets her taxes done.

Good point about deductions. The Roth income limit calculation doesn't allow mortgage interest deductions, but it does allow deductions for contributions to deductible 401(k)'s so Madame X should be able to sneak under the limits.

I have Wamu checking and opened a Wamu online savings at 5%. There is no minimum--it's all free Even though you have to open the account online, you get all the same benefits of a regular wamu account when you go into the bank. I like it because I can transfer money between my checking and savings instantly online (or over the phone or in the bank). The bad thing with Wamu is sometimes they put holds on deposits, even if you have the money to cover the amount already in your account. I never experienced this but my sis and best friend have several times and that is a headache for them.

I think you should look into an Etrade Complete savings account since you already have a brokerage account there. This is where I keep my freedom savings account and my rental property savings account.

go with a fidelity my smart cash account. it's a checking account earning 3.45% and you can have self-funded overdraft protection. i have $0 in the checking account and my liquid money in fslxx (though there are other good money market funds). whenever a check clears or you withdraw money at an atm, fidelity automatically sells that much of the money market fund. and...atm fees are refunded with no limit. i also got the fidelity visa credit card, which gives you 1.5% back on everything (though, like with most cash-back programs, you have to have a certain amount to get the cash you've earned paid out).

the only drawbacks (which are not a concern for me): the money market fund isn't fdic-insured; fslxx (not sure about other money market funds) requires $2500 as the minimum initial purchase; and depositing checks is done by mail unless there's a fidelity center near you.

for now, there's a promotion: $100 and 10,000 (15,000?) miles on UA or AA if you deposit $10,000 into fidlelity.

i had hsbc and moved all my money to fidelity. the $0 in the checking account with self-funded overdraft from an investment vehicle offering an interest rate that is as good as almost any online savings account is a hard-to-beat combination.

About Me

My name is Madame X, and I am a 40-something single woman living in Brooklyn, NY. I write about how much money I make, what I spend it on, how much I save, how I budget, my home-buying experiences, my financial goals and ambitions, my thoughts on class and what it means to be rich or poor, and anything else that relates to money. (More about me here, here, and here.)If you take any of my advice, do so at your own risk as I am not really qualified to give it. If you have advice to share, please do, and many thanks!Ad proceeds from this site are donated to worthy causes.